Investing in a Bear Market

On 09 October 2007, the Dow Jones Industrials hit a record high, closing at 14,279. What a difference a year makes: Last Friday, the Dow closed at 8451, and there’s a good chance it will drop even further.

Unsurprisingly, my inbox is filled with e-mail from people who wonder what they should do. Here are some typical questions from readers like you:

“Originally we had planned to open Roth IRAs this weekend, but with the stock market being so unreasonable, we have lost our confidence. Wouldn’t it be wiser to leave the money in our savings accounts for several more months?“

“I am 30 years old and since reading your blog, I realize how important it is to get a Roth IRA fired up. However, now that I’m financially ready, the market meltdown has confused me completely. Should I hold tight and just keep saving while I see how this rides out?“

“I have two 401k plans. However, the last time I looked at my quarterly reports, I noticed I am losing money. I know that the US economy has been pretty bad lately, but is there anything that can be done or planned for?“

These are fantastic questions. Unfortunately, there are no fantastic answers. Nobody knows what the market will do. Nobody.

I watched a news program today in which a pundit predicted the market has hit bottom and is ready to make a recovery. But there are others who believe stocks will continue to fall. I am by nature an optimistic guy, but even I start to feel gloomy and scared for the future when I read and hear some of this stuff. (Peter Schiff, especially.)

Unfortunately, neither I nor anyone else can tell you whether now is a good time for you to invest in the stock market. Only you can make that decision. I can, however, suggest four fundamentals to help guide your thinking.

Know your risk tolerance
The first thing you should do before you invest — now or at any other time — is to gauge your risk tolerance. When you buy stocks, there is always an element of risk, the chance that the value of your investment will fall.

Some investors can tolerate more risk than others. I used to believe I could stomach a lot of risk. I thought I was bold and aggressive. Then I made a couple of dumb investments, culminating with the loss of my entire 2007 Roth IRA contribution when The Sharper Image went bankrupt.

I’ve learned that I don’t actually have a high risk tolerance. I’ve funneled all of my money into index funds, mutual funds that track the broad movement of the market. These still contain an element of risk — the “broad movement of the market” has caused my index fund to drop 17.3% over the past two weeks! — but it’s risk I can tolerate. I know that my investment is doing no worse than the market as a whole.

There are several online tools that can help you assess your own risk tolerance:

If your risk tolerance is high, you can put more money into stocks. If your risk tolerance is very low, the stock market may not be right for you. Remember, a more risky type of stock has greater potential for gain as well as greater potential for loss. Lower risk stocks have smaller swings over the long term. If your investments are geared toward retirement, you should lower the overall risk level of your portfolio as you age.

Set investment goals
It’s important to know why you’re investing. What is your purpose? What are your goals? Do you need the money in a few years, or do you still have 40 years before you’ll need to draw upon it? Are you looking for the maximum possible growth? Or do you simply want to protect your capital — to not lose money?

The stock market is not the right place for short-term investments, or for those who cannot afford to lose capital. If you’re saving for next year’s vacation, you’re better off putting your money into a high-yield savings account or a certificate of deposit.

Are you saving for a medium-term goal, like a down payment for a house? Again, the stock market is probably too risky for holding this money.

But if your investment horizon is long-term, if you’re saving for retirement in 15, 20, or 30 years, then the stock market’s historical performance makes it an attractive option, especially when it’s down 43% from its peak.

That’s not to say that the stock market is always the best choice, even for long-term investments. Coupled with your risk tolerance, your investment goals can help you determine the proper asset allocation — the best way to divide your money among possible investments.

Diversify
Diversification is one of the cornerstones of Modern Portfolio Theory. Though it seems counter-intuitive, research indicates that owning investments of different types offers higher returns at lower risk. Diversification is simply the practice of owning many investments, of not putting all your eggs in one basket.

There are several ways to approach diversification, including:

Diversification among stocks — When you own a single stock (or a handful of stocks), you are subject to a lot of risk. But when you own a mutual fund — a collection of stocks — you are practicing diversification, spreading the risk among many securities.

Diversification among asset classes — Only the most risk-tolerant investors place all of their money in the stock market. Most spread it around into other “asset classes”. For example, I have my retirement in stocks, but I also have an emergency fund (in cash), and am accelerating my mortgage payments (real estate). I have friends who have diversified into precious metals, such as gold and silver.

Diversification over time — Some investors practice dollar-cost averaging as a means to mitigate risk. This can be an excellent way to invest in the market if you’re nervous about putting all of your money in at once. (Please note that dollar-cost averaging has critics with valid points.)

This asset allocation wizard from CNN Money poses a few basic questions about your goals and your risk tolerance to determine a framework for diversifying your investments. I told it that I needed my money in 20+ years, could handle some risk, was okay missing my target by a couple years, and view market sell-offs as a time to buy more stocks. The calculator’s recommendation? Almost exactly the same asset allocation as FFNOX, the index fund I’ve selected for my 401k.

Diversification can’t prevent stock market losses, but it can certainly reduce them. (Note that it also reduces market gains, however.)

Educate yourself
The final fundamental concept is also the most important. I believe that education is the most essential component of any investment plan.

Often, fear is a product of ignorance. When we don’t understand something, it scares us. But ignorance can be overcome through education. If the market meltdown makes you anxious, I urge you to do some research. Visit my collection of financial literacy resources and watch the video series about saving and investing. Go to the library and borrow one of these books:

I wish I could make all new investors set aside a few hours to read The Four Pillars of Investing. There’s a good chance it won’t make today’s investors any less nervous, but at least they’ll have a basis for making informed decisions.

Investing in real life
In The Only Investment Guide You’ll Ever Need, Andrew Tobias writes, “Buy low and sell high. You laugh. Yet most people, particularly small investors, shun the market when it’s getting drubbed…It’s precisely when the market looks worst that the opportunities are best.”

We all know this, but although the market is currently getting drubbed, the average person isn’t buying. The average person is panicked. The average person is selling. Friday’s edition of Marketplace featured some shocking stats. Last week, investors pulled $43 billion out of mutual funds. Two weeks ago, that number was $6 billion. The week before that it was only $5 billion. Why is the market dropping? One reason is that the average investor has panicked.

If the average person is selling, then who’s buying? Who’s crazy enough to buy when everyone else wants out of the market? I asked some of my colleagues about their recent money moves. Here’s what they said:

Jeremy from Gen X Finance told me: “Buying opportunities like this don’t come around that often, so my only regret is that I don’t have a lot of free cash on hand so that I can pick up a lot of beaten down individual stocks.”

Patrick from Cash Money Life says: “I plan on opening a self-employed retirement account soon with my web income, and will probably also put more money in equities where I can. I’ve been hoarding cash for several months and I think it is a great buying opportunity right now. I’ve got 30 years before I reach retirement age.”

Blunt Money writes: “I’m continuing automatic investments as well, although I did allocate a portion of new money for those to a fixed income fund. I also put additional money into single stocks.”

JLP at All Financial Matters, a financial planner by trade, writes that for a long-term investor, the current market is a gigantic sale.

What about me? I recently took as much money as I could it and pumped it into FFNOX. I bought in at $24.20. Its current value is $20.01. It’s down 17.31% since I bought it. So what? If I had bought it a year ago, I would have paid $32.71. If I get a chance to buy more FFNOX in the next few months, I will. Yes, it’s scary to buy as the market is falling, but I know that I’m purchasing a broad-based diversified index fund. Also — and this is key — I believe that the market will turn around.

Now maybe all of us personal finance bloggers have been drinking the same Kool-Aid. Maybe we’re suffering from mass delusion. If so, we’re not the only ones. Warren Buffett, the world’s richest man, is on a buying spree. So are Mark Cuban and many others.

But you don’t care about all those other people, do you? You care about yourself and your money. Rightfully so. What should you do? You are the only one who can make that call. You are the only one who knows your own risk tolerance, your investment horizon, and your savings goals. Educate yourself about investing, and then make decisions based on your own objectives and your own assessment of the market.

If you’re still uncertain, seek professional advice. Find a fee-based financial advisor to help guide your decisions.

The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He should never buy a stock because it has gone up or sell one because it has gone down. He would not be far wrong if this motto read more simply: “Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.”

If you believe stock prices are still high, then steer clear of the market. If you think they’re low, then buy. And remember: Unless you sell your stocks, you haven’t lost anything at this point — it’s all on paper.

During the tech bubble, I was part of an investment club. The other guys and I chortled with glee as we bought tech stocks (Celera Genomics, Home Grocer, Triquint Semiconductor) near the top of the market. We thought we were going to be rich. We weren’t laughing so hard when the bubble popped; we closed the club and sold the stocks at huge losses. What lesson did I learn? The time to buy is when prices are low, not when they’re high.

I believe that for the average long-term investor, the best course of action right now is to make regular scheduled purchases of low-cost diversified index funds. That’s what I’ve done, and that’s what I intend to keep doing.

I think that from a psychological point of view, dollar cost averaging is the way to go. We have some cash to invest and we’re going to spread it out a bit. That way at least some of the purchases will be at “the bottom” and we can feel good about it.

Reading Four Pillars and Random Walk etc is an excellent suggestion – the more knowledge you have about how the markets work and particularly past history, the better off you will be in rough times.

I agree with JD, no one can tell you whether now is a good time to invest for you. Age, risk tolerance, long term vs. short term investing, your overall financial health (i.e. do you have a ton of credit card debt, etc.) all need to be considered before investing.

We continue to invest in our 401k and we recently started funding our 2008 IRAs. We use our IRAs to buy stock and for us now is a good time to buy stock in good undervalued companies. We have all our debt paid off, except our mortgage, we have an emergency fund, we have other savings and we are funding our 401ks so it makes sense for us to buy stock in our IRAs.

Could the stock market continue to go down, yes, could we lose money on these stock purchases, yes, but in the long term (we plan to hold these stocks for 20+ years) we think we will make money and like JD said buying low is better than buying high.

I am 23 and do not see this as a “financial crisis” for me at all. I have been referring to it as the “financial opportunity” instead. The analogy that I have been telling all of my friends and family is that right now is “The-Day-After-Thanksgiving-Sale” for investing.

At my age, even if I buy and the market continues to fall it eventually will turn itself around. What I don’t want to do is miss this low buying price opportunity. One might ask why I don’t just wait to buy at the lowest price. If I knew what the lowest price would be, I would not sitting here at work right now.

I think it’s worth pointing out that whether to invest in the stock market is a different question altogether from whether to open up a ROTH IRA (or other retirement vehicle). If your risk tolerance is low, you can put all or some of your money in a CD or bond fund through your IRA. It’s actually quite tax efficient to do so. I have a good portion of my IRA in Vanguard’s Total Bond Market Index Fund, and I’m getting fairly stable appreciation (with interest reinvested) without having to pay taxes on the interest, which I believe — though I’m no tax expert — would otherwise be taxed at normal income rates. Ditto for CD interest. Maybe a good first step for people is to open up the Roth IRA, put the bulk in non-stock investments, and then, as ABCs mentioned above, to dollar-cost-average into the market over the coming year.

Unless your retiring tomorrow there is no need to worry- and if you do decide to panic your only “locking” in your losses. Watch what the big boys are doing right now like Warren Buffet. They are buying, and unless you’ve got bills to pay off and are in great debt you should do the same.

JD – Thank you so much for all of the work you do here.
Having procrastinated about funding my SEP IRA-(who could blame me?-it’s at WAMU Investments,INC)- The October 15th tax filing deadline approaches. I have been paralyzed about what to do having paid my taxes based on my commitment to contribute a certain large (to me) figure.
I am having a free consultation this morning with a financial firm.
I am concerned about opening another SEP with Vanguard, Fidelity or American Century Funds. Can I open another SEP?
There will be a fee to move the money out of the WAMU account. So I am looking for a “no load”fund. Somewhere. Soon.

I have a similar question, but not so much because I’m worried about investing.

By April, my husband and I will have close to three months of living expenses in our emergency fund, BUT, since he’s 32 (I’m 27) and neither of us have money in a retirement fund, should we fund his for this year and then build the emergency fund back up? We had planned to start maxing out our IRAs after the emergency fund was complete, but I wonder, considering our age (esp. his) if it wouldn’t be better to get some money into an IRA THIS year.

I’m not worried about the stock market too much. Maybe I should be more concerned, but I see it as a great opportunity to buy.

I just came over to say basically what Ada said, so I agree with that point! If you really can’t stomach the market right now, don’t use that as an excuse to miss out on a year of your annual IRA max. Even if you put the money into a CD within an IRA, anything you earn will be tax advantaged one way or the other.

Personally, I have continued to invest. I feel fine about our household asset allocation. I actually do not buy into the concept of holding only one or two index funds, and I have made different fund choices that are holding up pretty well. I even increased my exposure to stocks this entire year, as I feel that they are a bargain. I expect the market to go even lower. I don’t think we have hit bottom.

But how can you possibly buy low and sell high if you take all your money out at the slightest wobble? In a taxable account, this might be a good time to sell some things at a loss for tax purposes, but in the average retirement account with 30 odd years to go, I feel that sitting tight is the way to go.

Case in point – I had a 401(k) that I started in 2000. In 2001, my company did something shady as they went out of business, basically skimming contributions to pay bills. The accounts were tied up, frozen, until they repaid the money. So we couldn’t alter investments during the tech crash, and on paper, my account lost most of its value. I finally got around to rolling it over last year, and what do you know, I’d made a 12% lifetime return despite that fluctuation. I think this was helped by the fact that the missing money was repaid during a low point in the market, and I ended up with more cheaper shares.

So I am leery of trying to time the market, as everything I’ve read suggests that if you miss the few best days of the market, you basically miss out on maximum growth chances.

I just recently became eligible to contribute to a 401K. I actually think I’m quite lucky to be investing in a down market. I have had panic moments because I don’t know what I am doing – I’m not a professional. I’ve been investing in managed index funds and trying to hold onto my stomach.

I did cut back slightly on my contribution rate, but that’s because I need more cash on hand for a new car purchase soon.

I had an interesting conversation with my 93-year-old grandfather last night. After a lifetime of teaching (starting salary: $0.50/week), he and my homemaker grandmother have a very comfortable life.

So I called him to talk about the market and a few other things. What struck me most was how carefully he has considered their needs in choosing his financial positions.

They cashed out of all but index funds when they moved into a retirement community and knew that they were going to require a stable income that would be largely immune to market fluctuations, and put everything in bonds and snowballing CDs (although he didn’t call them snowballing or laddered, he just explained the concept).

And then he said, “Dolly, you’re not going to retire for 33 years, and if you have been watching stocks and saving your money, this is a good opportunity … if you’re brave. But if it’s going to give you heartburn every night, it’s an opportunity to make money, but not an opportunity to feel good about the way you made it.”

I’ve been a fan of Andrew Tobias for awhile, but just read “Smartest Investment Book You’ll Ever Read” by Daniel Solin. I liked the exercise for determining your risk tolerance and wish I had something like that 20 years ago. He also has a 401(k) book out that I want to get my daughters. I see Peter Schiff has a new book out (and Harry Dent has one coming out in a couple of months) so will see if I have the fortitude to read them. I’m also interested in the “Little Book that Saves Your Assets” but the library doesn’t have it yet. I have the 4 Pillars book in the queue. What I am finding is that my risk tolerance isn’t what I thought it was, but this could be because I am near retirement. Thanks for the book recommendations.

WRT Four Pillars: I was just re-reading my copy of this over the weekend. The chapter about market bottoms is eerily on point. It provides a bit of solace and perspective when you’re losing your tail in the a particular asset class.

JD, it’s these kinds of insanely useful posts that make you the blogging god that you are.

I make automatic investments into index funds every month no matter what, but I know this article was a help to thousands of your readers. If there was a nuclear war, I *might* stop investing in index funds each month, but then I’m probably not going to care about my portfolio at that point anyway.

For people just getting started, Vanguard is the most recommended investment company, period. I can safely say this after having read dozens of PF books and thousands of articles. And the easiest way to invest in broad index funds w/ Vanguard is to simply put some of your investment money in their Total Stock Market Index and some of your money in their Total International Index. Your money would then be invested in every stock in the world; you simply can’t get any broader than this plan. Start now and keep investing every month. You stop only if there is a nuclear war. All this assumes that you are a long-term investor.

I am continuing to buy a low-cost index fund with every pay period, taking advantage of dollar cost averaging. Then again, I have at least 30 years until retirement, so I can avoid looking at the statements for quite some time. For those who have a lump of cash (401K), it would seem buying in over time might offer the lowest risk, because not even Warren Buffett can predict with certainty when the “bottom” is.

I was recently told by my financial advisor that he expects a typical post-crash bump, and that then he expects a SECOND crash before we begin the slow creep back up. Who knows if its true, but I told him I don’t want to bet on timing, I don’t think we’re smart enough – just keep buying slow and steady, in a Vanguard index.

I have an MBA and if I learned *one* thing, its NEVER buy individual stocks. JD has written about this before.

I am a firm believer that your philosophies are the true measure of your success. I think that you’ve given some good guidance for the new investor, as well as the seasoned investor. Right now, I keep most of my money in an ING account. But seeing how the market is going, I can’t help but feel like the stock market is a good starting place now for new investors. My lack of knowledge of the fact is reason enough for me to hold tight though. Any suggestions, otherwise?

I have a 30 year horizon before I can tap into retirement accounts, so I plan on maxing out everything I can in that respect. I’m not very interested in tomorrow’s closing prices, but those of tomorrow’s tomorrow.

If you are going long and can handle the risk, I think now is the time to follow Warren Buffet’s advice: “Buy when everyone else is selling, and sell when everyone else is buying.”

My wife and I set up our retirement accounts in July of ’07. We made the bulk of our buys around September and October (when the market was at an all time high). I’m loving this downturn; I’m purchasing double the amount in my accounts than I was a year ago for the same amount of money. This downturn is driving down my cost basis and increasing my share position. I’ve got over 30 years before I retire. In my opinion, the market is on sale.

Buffett once said that a common fallacy among investors is a wish for increasing market gains. In fact the opposite is true; investors want the market to turn down to buy at better prices. That’s why we see Buffet back up his semi-truck of investing power and purchase huge positions in good companies in times like this.

I love your blog JD, but you are still drinking the Kool-Aid along with the majority of personal finance bloggers. You are caught up in mass delusion.

The party is over, the age of prosperity in America propped up by borrowing money from the savers of every other nation is over. Now is not a good time to invest in stocks, which are likely to continue to lose value for years, followed by a cycle of inflation that will reduce their value even more.

Get out before your money is completely gone. “It will come back” they all say, but when will in come back and what will the value of the dollar be when it does are big questions – with a lot of downside risk.

If you get your money back after the dollar loses 80% of its value – then you have lost 80% of your money. It took 27 years for the stock market to recover after the first great depression. Are you perpared to wait for it to come back?

(Please note that dollar-cost averaging has critics with valid points.)

You are being far too open-minded. Anyone who calls a generally accepted theory, “bunk”, is probably the pot calling the kettle black. Like almost every risk-management strategy, dollar cost averaging will reduce your return right along with your risk.

The price you get for your shares when you sell them will be the same regardless of when you bought them or how much you paid. If you invested a lump sum a year ago, you now own a lot less stock than if you had invested the same money weekly. And if you invested that lump sum today, you would own almost 50% more stock than if you had invested it a year ago.

Essentially putting all your money in the market at once is taking the same short-term risk as a day trader. If you happen to hit the market on a downturn, you come out ahead. If you happen to hit it at a peak, you are going to come out behind. The more volatile the market, the bigger the risk you are taking with a single lump purchase.

I agree with JD, no one can tell you whether now is a good time to invest for you.

There are only two prices that matter – the price you pay on the day you buy and price you get on the day you sell. Any gains or losses in between are just mind games. So, if the idea is to buy low and sell high, this is a terrible time to sell and a great time to buy. Regardless of your “risk tolerance”.

The key issue when buying is how long it will be before you want to sell the stock and use the money. If you are going to need the money soon, then the current uncertainty about the direction of the market makes buying a huge risk. But if you aren’t going to need the money for 40 years, the next month of market fluctuations isn’t going to have much meaning except that if it goes down further you missed the opportunity to buy more stock at an even lower price.

In terms of retirement, most of us are buyers. We aren’t going to have to worry about our selling price for a long time. If you have extra money lying around for retirement, now is probably a good time to buy stock. You might do better next month, but then again you might not.

Of course there is always the risk that the market will never go back up. That has yet to happen in the long run. But it was almost 30 years before people got back to even after the 1929 crash. In the long run, we are all dead – unless we are incorporated.

“Unless you sell your stocks, you havenâ€™t lost anything at this point â€” itâ€™s all on paper.”

This isn’t true, and if you interpret it in a way that makes it true then it’s meaningless.

If your stocks are down then you purchased something that now has a different value than when you purchased it. It may go back up in value, it may go down in value. But the fact is that in this moment the total value of what you have is less than it was before. There’s no getting around this.

What may or may not happen in the future has nothing to do with where I stand right now. As an investor you should be able to come to terms with the fact that you may gain or lose obscene amounts of money in a given day and those gains and losses are 100% real. Now they will hopefully even out in the long run to give you a slow steady gain, but they are no less real.

s an investor you should be able to come to terms with the fact that you may gain or lose obscene amounts of money in a given day

As the Yale economist Robert Shiller has pointed out, stock values aren’t “money”. They are just guesses of the stock’s value based on what a very small group of people who are buying and selling today think the stock is worth at this moment. We extrapolate a value from that.

This is why, unlike money, stock value can just disappear and reappear.

Excellent post. You make a number of very good points. There’s been so much written about how we got into this mess, and I wanted to point people to Plunder. Danny Schechter identifies some of the shameless profiteers and calls for an investigation of those behind this shrewdly engineered subprime Ponzi scheme.

In my mind, there is “risk tolerance” and there is “stupid”. Risk tolerance can guide you through the types of markets that were normal up until last year. When you put money into a market with this much volatility, anything other than cash and T-bills is just stupid. We don’t know where this is going. Keep your powder dry until the waters calm.

I have to disagree a little bit with Justin. The losses aren’t real until the stocks themselves are sold or the company goes under. If you’re that down on the investment, then it probably isn’t a well run company in the first place (and you should get out by all means).
This is true for both positives and negatives, you really didn’t make a lot of money at the height of the market unless you sold out at a positive. Just because the value of your stock moves up or down, it’s not real until someone else buys it from you.

When you put money into a market with this much volatility, anything other than cash and T-bills is just stupid.

No, in fact the contrary is true if you are prepared to buy and hold investments long enough. This again is the illusion that you lose “money” when the market declines. You don’t. Money is involved only when you buy stock and when you sell it. It doesn’t matter how many ups and downs there are between those two events.

If you plan to buy stock and hold it for 20 years then the only thing that matters is how much you think it will be worth in 20 years. The current market just means you can buy the same amount of stock cheaper than you could a year ago.

“When you put money into a market with this much volatility, anything other than cash and T-bills is just stupid.”

No, in fact the contrary is true if you are prepared to buy and hold investments long enough. This again is the illusion that you lose “money” when the market declines. You don’t. Money is involved only when you buy stock and when you sell it. It doesn’t matter how many ups and downs there are between those two events.

If you plan to buy stock and hold it for 20 years then the only thing that matters is how much you think it will be worth in 20 years. The current market just means you can buy the same amount of stock cheaper than you could a year ago.

I’m 26 (I just wrote 25 and then realized I was wrong… that made me feel old) I’ve been contributing 7% of my 28k/year to my 401k since about a year ago… one month after I was eligible by my company’s policy.

I have at least 40 years until I retire… maybe more if I really love what I’m doing at 65 and am in good health. I don’t want to worry about it, but I’m a worrier by nature so it does take a little bit of a pep talk to remember that what I’m actually doing is getting a screaming deal on something who’s value won’t matter much for 30 years.

@Ada #6: It’s a good point, and I do have some of my Roth IRAs in fixed income investments. However, you mentioned CDs and bond funds. Unlike CDs and individual bonds, bond funds don’t have maturity date and, consequently, their value fluctuates. Individual bonds – government, municipal or company have a specific maturity date; so while municipal or company bonds may carry some risk of default, the risk is small provided you buy AAA bonds. But bond fund value is based on value of all bonds it contains on the secondary market. This value is usually goes up when the interest rates go down, but they can go significantly down when the interest rates go up. So there is risk with bond funds. Personally, I see no reason of buying bond funds – you can always buy individual bonds and keep them to maturity.

The risk is supposed to be small, but all those bonds backed by real estate that are causing the current problems were rated AAA. The only really AAA bonds are US government issues. And you can argue about that.

The distinction between bonds and bond funds is a good one. The advantage of a bond fund is the same as a mutual fund, diversification. But, as was pointed out, unlike owning a mutual fund owning a bond fund is very different than owning the underlying securities.

There are too many variables to give a one size fits all answer(as JD and others have pointed out).

A lot also depends on your risk tolerance. There is nothing wrong with putting money into a savings account of CD if you tolerance for market fluctuations is low.

If you have a longer time frame or if you are ok with knowing it may drop in value the coming months may be an excellent time to buy.

If you are going to buy do not go all in or for that matter all out at one time. Buy and sell in blocks. I learned this the hard way one time I sold all of one stock I owned and the next day was a big run up that I missed. Ideally I should have sold half then waited and sold the other half.

Rather than waiting until April to make the entire contributions, my husband and I are going to make half of our annual Roth IRA contributions tomorrow! We are excited to be contributing while the market is at a low point, as we won’t be cashing in for decades to come. For any young people out there, I want to encourage you to invest what you can now, as long as you’re investing in products not outside your comfort zone!

For example, I have my retirement in stocks, but I also have an emergency fund (in cash), and am accelerating my mortgage payments (real estate).

I’ve seen others make this same mistake: paying down your mortgage is not an investment in real estate. You made your investment in real estate the moment you signed that mortgage. Paying down the mortgage has no effect on your asset allocation, nor does not increase your exposure to the real estate market. It is paying down debt, pure and simple.

â€œIt took 27 years for the stock market to recover after the first great depression. Are you prepared to wait for it to come back?â€

This is true, but in all market history, there was only one great depression. After other crashes the market recovered sooner. After 1987, it took only a couple of years if I am not mistaken.

We don’t know if this situation is more like 1929 or 1987. Sure, there was no recession in 1987, and there is one now. But there are differences between now and 1929 as well, specifically the government policies and the cooperation between countries. After the 1929 crash, the government raised the interest rates. Sure, they had kept them too low in the 20s, but after the crash the economy was contracting which brought inflation pressures down, and raising interest rates was not needed and was exactly the wrong thing to do. 2) There was no FDIC, so when over 9000 banks failed throughout the 30s, people lost their money. This is not the case now. 3) As businesses started to fail, the government introduced the tariff that resulted in retaliations that resulted in higher prices that nobody could afford. Today, at least for the moment, the countries cooperate to try to resolve this crisis.

Sure you can say that with all this liquidity we will get inflation and higher prices, but at the moment the slowing economy, unemployment and lower oil prices there are anti-inflationary pressures as well. We may still get it later, but then the government can raise rates.

Additionally, if you believe that we’ll have huge inflation, cash isn’t going to help you either. Gold might, so certainly, if you are 100% sure we’ll have hyperinflation buying gold may be the right thing to do. But a) this may not happen and b) remember, there was Gold Confiscation in the 30s…. Sure not that currency is not backed by gold it’s unlikely, but if the currency becomes worthless, who knows.

Besides, the great depression’s spread to other countries may have indirectly contributed to Hitler’s rise to power in Germany and, hence, the second world war. Given how interconnected the world is now, you may well believe that another such event may lead to pretty bad things. In this case whatever you do is not going to help. So we may as well plan for other scenarios.

So really, if you believe that the world is going to come to an end there is not much you can do other than maybe buy a farm and grow your own food. Thus, it seems to me we should consider other possibilities i.e. that we’ll have a shorter recession and that the economy will grow again.

I am so glad you pointed out that if you have not done anything in regards to your (stock market) investments, you haven’t lost anything. “It’s all on paper.” I am so tired of hearing people say they have lost all this money, when they haven’t actually done anything with their accounts. Their shares don’t disappear if they are in a mutual fund (and I feel comfortable saying that’s where their investments are since they are talking about their 401K’s). It frankly makes me think that these people must be incredibly financially uneducated (though they seem to be well-off).

The only people that I can see having any real need for concern is those who are actually already in, or very near, retirement, and if they have an emergency fund they can live on for awhile (or are more invested in cash funds, which they should be) they can also ride out this turmoil.

Ross Williams (comment #25): That is a beautiful analysis of dollar cost averaging. You made it so clear in a single sentence, “Like almost every risk-management strategy, dollar cost averaging will reduce your return right along with your risk.”

To everyone who says you are ready to wait 27 years for stocks to return, I applaud you. I actually hope to retire sometime between 2024 and 2035, so I suppose you could say I’m willing to wait that long.

But the truth is, it could be very hard to do. It seems easy when the market has only been down for a year. But what if the market see-saws for a decade of stagnation? It will be a lot harder to stay the course then. No one knows the future of course, and this particular bad spell has required a modicum of resolve. But a greater test of faith could still be in the future.

For what it is worth, I intend to stick to my plan. It has worked well for me for the last 10 years, balancing my risk and return. But I still keep in mind that it could be much harder (emotionally) down the road.

Germany was already in the midst of its own economic depression in the 1920s before the Depression began in the U.S. Germanyâ€™s depression was basically imposed by the harsh conditions of the Treaty of Versailles, which called for Germany to pay reparations for its aggression in World War I. It was more likely life under the harsh economic conditions in Germany in the 1920s that set the stage for Hitlerâ€™s rise to power on a platform of restoring Germany to its place of power on the world stage, rather than the U.S. Depression, which occurred later. The world economy is in a very different place now, so we’ll just have to watch and see what happens!

To Allison:
It is indeed true that the Germany was hit hard by the Treaty of Versailles, so the economic situation in Germany in the 20s was not good. However, it was propped up by huge loans from the US in 1924 (under the Dawes plan) and in 1929 (the Young Plan). After the crash in 1929, America needed these loans back to assist American economy. After the crash, America gave Germany 90 days to start to re-pay the money which devastated Germany – between 1929 and 1930 the unemployment doubled. In 1930 – one year after the crash, the Nazis gained a whole lot of seats in parliament – a lot more than expected.

If you google for the Great Depression + Germany, you’ll find a lot more information that confirm what I said.

Yes, the world is a different place. But given the world government interventions in the current crisis, I don’t believe we are headed for the great depression. If we are than heaven helps us all as some of the emerging markets can be hit badly, and they may not be that stable politically.

Unless you are planning to liquidate your holdings within the next week, you are not “participating in 1000 point daily volatility.” I don’t care (at least with respect to my 401(k)) whether the market drops 1000 points tomorrow. I’m not retiring for another 35 years.

If you are planning to liquidate your holdings within the next week, then you shouldn’t be in the stock market.

And remember: Unless you sell your stocks, you havenâ€™t lost anything at this point â€” itâ€™s all on paper.

I’ve heard this advice before and I understand it is supposed to help investors cope with volatility. That said, I think it’s a terrible way to invest.

J.D. provides great examples of why it is poor advice in his very next paragraph. Home Grocer went to zero, while Celera Genomics and Triquint Semiconductor are down ~80% from 2000. Investors in Home Grocer lost everything – and it wasn’t just ‘on paper’ – and Celera Genomics and Triquint Semiconductor would have to go up 500% to recover their losses.

Take Lehman Brothers or Washington Mutual as more recent examples… both trading around $0.10. That’s nearly a 100% loss from pre-crisis levels.

Josh @55: Good comment. It is important to look at paper losses as just that, and NOT get freaked out when you see you’ve lost $2,000 in the last week.

It is not really true that you haven’t lost anything when stocks drop that $2,000. You HAVE lost $2,000. You own an asset that dropped in value by $2,000. I’m not sure what is confusing about that.

The point of that comment is that the $2,000 is possibly normal market fluctuation. People who own SUVs saw the value of that SUV drop when gas prices skyrocketed. Did they “lose” money? They sure did. But they still have the same amount of cash and assets as they did before they lost that money. Thus, they will not REALIZE that loss until they sell the SUV. That does not mean they have not lost it, though.

Have they lost $2,000? They sure have. But they still have $50k in cash and the same SUV, so nothing has changed for them yet (ie, they have not realized the loss).

It is misleading to say “Unless you sell your stocks, you haven’t lost anything at this point”. Yes, you have, and you better not take cutting your losses off the table as an option. BUT don’t let normal market volatility push you into buying high and selling low. In fact, I would suggest re-reading JD’s entire article again and just skipping the above sentence. The rest of the article about risk tolerance, etc. is spot on.

You own an asset that dropped in value by $2,000. Iâ€™m not sure what is confusing about that.

There is nothing confusing about it, its just not true. Its only an estimate of the value that declined. That estimate is extrapolated from the price that the people who were buying and selling today settled on.

Investors in Home Grocer lost everything – and it wasnâ€™t just â€˜on paperâ€™ – and Celera Genomics and Triquint Semiconductor would have to go up 500% to recover their losses.

Take Lehman Brothers or Washington Mutual as more recent examplesâ€¦ both trading around $0.10. Thatâ€™s nearly a 100% loss from pre-crisis levels.

I don’t think anyone should believe it is inevitable that they will get the opportunity to sell at a higher price than they can today. But until they sell, they haven’t made or lost any money.

In the examples you use the company went out of business. They have no value – their shareholder’s losses have been realized. That is not a market estimate.

But in a market where lots of people want to sell at any price and lots of people don’t want to buy at any price, the market price is going to be low. You can’t really extrapolate a value from that. It just doesn’t tell you anything (or much of anything) about the value of the companies you own shares in. It just tells you how those transactions happened today.

‘If the average person is selling, then whoâ€™s buying?’
I couldn’t be more than surprised to read this line. It was as if you overheard my conversation with a friend from across continent!
Just the information that I was looking for! Keep up the good job!

The real estate market is a good example of how unrealized gains and losses don’t translate into money. The market value of a lot of people’s homes doubled or tripled. But to realize those gains, they would have had to sell the house and find another place to live. Which would either cost as much as the one they sold or not be as nice. In essence, the value of their house hadn’t changed at all.

Some people still made a lot of money in real estate and others have lost (and will continue to lose) real money. But for people who owned homes through the bubble and never refinanced, they never really made any money and they aren’t losing it now. Until they realize the change, its just a mind game.

Ross @57: I find your comment odd, to say the least. If you have an identical product to one being purchased by the market at $x, how can you say that the current market value of your product is anything other than $x? If no one is willing to pay >$x, then it is not worth >$x. This is a fundamental (perhaps slightly simplified) meaning of “worth”. I don’t understand your comment that this market value is only an estimate of current market value (seems inherently contradictory). In this case, if the market is willing to purchase a car identical to yours for $2000 less than it did the day before, then your current wealth has fallen by $2000. If all your wealth is in gold, then your wealth would be measured by the current dollar value of that gold. This is not the only measurement of wealth, but it is what one would typically use, as it removes the complexity of measuring wealth in buying power (ie, attempting to account for inflation).

The only other value that is worth discussing is what you personally value the product at, which may or may not be $x. In this case, even if the market value of your car has fallen $2000, if you still value it the same then the personal valuation of your wealth has not changed.

Ross @59: Again, I am struck by your comment. In fact your example is a great mental exercise to counter your argument. The very fact that one can refinance and “extract” more money out of their home without selling is exactly evidence that the value has increased. It is not a “mind game” but real change in value. If the value had not changed, banks would not be willing to lend money beyond the purchase price (illegal bank tricks aside).

How do you explain this if the value did not actually increase? Are you suggesting that the refinance in itself CREATED value? The refinance is only a measure or an evidence of a change in value. A refinance cannot create value.

I think there is some talking past one another going on here. The question is whether you made or lost “money”. Value is a much broader term.

The very fact that one can refinance and â€œextractâ€ more money out of their home without selling is exactly evidence that the value has increased.

If a real estate appraiser puts a $400,000 valuation on your house one day and another appraisor says its only worht $350,000 have you lost $50,000? Or made $50,000? That is how the market sets value – it is an estimate and until you actually sell or buy, that is all it is.

How do you explain this if the value did not actually increase?

After your original purchase you own one home and owe the bank $180,000. After refinancing, you own the same home and owe the bank $225,000. You also have $55,000 in cash, including the additional $45,000 you have borrowed and the $10,000 you paid on the first loan.

If no one buys my goods at the market today, does that make them worthless? Of course not. Actual monetary value is determined when something is sold and that value realized, until then we use the market to estimate its likely value. But its a guess extrapolated from a very small sample.

Again, like I said in my original comment, this is evidence of increased asset value. Your math with the loan is a red herring. Take out financing altogether and assume that there was no original loan and the individual bought the home out outright prior to the $50,000 appreciation.

I don’t know why you are bringing up appraisals. Appraisals are an estimate of market value. It’s one guy or gal saying what he or she believes the market will pay for the asset. The answer to which estimate is correct is based on what the market would actually pay. This is akin to a small group in your company pricing a product to what it believes the market will pay. There IS AN EXACT MARKET VALUE at that very moment, and your estimation will either be correct or wrong.

Ross @63: If no one is willing you purchase your goods at the market today at any price, THEN THEY HAVE NO MARKET VALUE. If no one is willing to purchase your goods at the market today at the price you are selling, then your price is too high (see above about price vs market value). Again, this is not complicated. I’m not sure what the problem is here.

These are NOT estimates. The market determines the market value, and that can change on a day to day or minute to minute basis. It does not make sense to say the value of your asset has not changed if the market has changed its mind about the value of your asset.

our math with the loan is a red herring. Take out financing altogether and assume that there was no original loan and the individual bought the home out outright prior to the $50,000 appreciation.

Its not a red herring, as your new example again demonstrates. To start with they owned a home. After taking out the loan they won the same home, they owe $50,000 on a loan and they have $50,000 in cash. Again, where is the “money” they made on the house?

The answer, of course, is that there isn’t any. Until they sell the house and realize a profit all they have is an estimate – a guess – about what the house will sell for. And, as many people have recently discovered, that is not the same as money in the bank.

if no one is willing you purchase your goods at the market today at any price, THEN THEY HAVE NO MARKET VALUE.

And presumably neither do the goods you didn’t offer for sale? It seems a bit bizarre to say that the tomatoes the farmer offered for sale, but failed to sell, are worthless. But the tomatoes he left in his storehouse are worth whatever other farmers sold their tomatoes for that same day.

The reality is that the tomatoes’ monetary value isn’t set until they are sold. Until then, you are extrapolating a value. Its just an educated guess about how much they might sell for.

@Matt: I read the whole article and I think it’s terrific. That one sentence just rubs me the wrong way.

@Ross:I donâ€™t think anyone should believe it is inevitable that they will get the opportunity to sell at a higher price than they can today. But until they sell, they havenâ€™t made or lost any money.

In the examples you use the company went out of business. They have no value – their shareholderâ€™s losses have been realized. That is not a market estimate.

Only one of the companies in my example went out of business (Home Grocer). Both Lehman and WaMu still trade, as do the other two companies J.D. invested in. Therefore, shareholder’s losses have not been realized.

Your logic dictates that investors in these companies haven’t lost any money over the past 6 years.

The ‘real estate’ and ‘market goods’ examples are poor. They demonstrate effects of illiquid markets. Stocks, on the other hand, are generally very liquid.

If the investments in your retirement portfolio currently trade at 50% of your purchase price, it’s very dangerous to think that you haven’t lost any ‘money’ because you haven’t realized the losses.

One can’t pretend that they have not lost money simply because they haven’t made a transaction at the current market price.

If the investments in your retirement portfolio currently trade at 50% of your purchase price, itâ€™s very dangerous to think that you havenâ€™t lost any â€˜moneyâ€™ because you havenâ€™t realized the losses.

It is equally dangerous to think you have made “money” if you haven’t realized the gains. In both cases, you still own the same stock you bought and until you sell it you haven’t lost or made any money.

If you own Home Grocer stock, there are plenty of reasons other than the market estimate to wonder about how much value it has. When your house burns down you don’t need market comparables to know its worth less than what you paid for it.

Your logic dictates that investors in these companies havenâ€™t lost any money over the past 6 years.

Where is the money they lost? The spent money to buy stock, they still own the stock. Until they sell it they don’t know how much money they have lost. The market is giving them an estimate – but that’s all it is. There are plenty of reason’s to think the current market does not provide a very good estimate.

When you buy 100 shares of stock at $50/share, you lose $5,000 of â€œmoneyâ€.

No – I don’t “lose” money at the grocery store. You spend money on stock, but stock is not the same as money in the bank.

Your contention seems rather academic and semantic, thus not very practical.

There is nothing academic about the consequences to people who they had made “money” on their house during the real estate bubble. Many of them spent that “money” on all sorts of things. Now they are discovering that money wasn’t theirs, it was just another loan like charging stuff on a credit card only at a lower interest rate.

The same is true for people who own stock. The consequences of the misconception that you make or lose “money” when the market goes up and down can be seen in the public debate over creating personal investment accounts as an alternative to Social Security. Just talk to someone who is having to cash out their stock for living expenses right now. It doesn’t matter how much the stock was worth a year ago.

Just talk to someone who is having to cash out their stock for living expenses right now. It doesnâ€™t matter how much the stock was worth a year ago.

By your definition, it doesn’t matter how much the stock was worth one tick before they sold, let alone last year. This person wouldn’t have lost any “money” until the instant they sold; no sooner. Until that very second, it was all on paper.

So would you argue that they shouldn’t have done anything like:
– reduce living expenses as their account value fell,
– planed to work longer,
– invested more money into their account,
– or engaged in any other behavior to react to their declining account value?

Please don’t address whether this person could do the above; that is not your argument. You claim they haven’t lost any “money”. Why should they change their behavior?

Before you take exception to the above, remember what you recommended those who made “money” on their house during the real estate bubble should have done: nothing. They shouldn’t have spent “money” they didn’t have. The same reasoning dictates that you shouldn’t concern yourself with “money” you haven’t lost.

This person wouldnâ€™t have lost any â€œmoneyâ€ until the instant they sold; no sooner. Until that very second, it was all on paper.

That’s right. And if they didn’t sell, they haven’t lost any “money”.

The sale did not cause a change in value.

Of course it didn’t. But you certainly didn’t make any money until you sold it. And how much money you estimated you would receive three months earlier or three months later is irrelevant.

You claim they havenâ€™t lost any â€œmoneyâ€. Why should they change their behavior?

They shouldn’t. Isn’t that basically the argument being made for why people should stay in the market? Their behavior shouldn’t be based on what is happening to stock values. And that is the same reason people should move their assets into money as they get closer to needing to use it.

People who equated stock value with money are the ones making forced sales of stock right now. And if you are one of those people, then yes you need to change your behavior. But if you always treated stock values as estimates then, no, you shouldn’t have to change your behavior when stock values fall.

Ok, I think I finally understand what the problem is here. You are talking literally about dollars. Yes, you don’t make any “money” from gold appreciating 50% because the value is still in gold. But that is kind of a pointless distinction. If today I can buy 3 widgets with my 1 gold bar and tomorrow I can buy 5 widgets with my 1 gold bar, the 1 gold bar has increased in value. Have I made “money”? Well, no, if you are talking about dollar bills, because I have not decided to exchange my 1 gold bar for dollar bills. But I have certainly become more wealthy, (holding the value of a widget constant).

“And how much money you estimated you would receive three months earlier or three months later is irrelevant.”

It is not an estimate! It is a true change in value. I still do not understand the breakdown we’re having here. Does the above example that does not involve dollar bills clear up the point of estimate vs. true current market value??

No it isn’t pointless. What is pointless is saying you made “money” because someone else paid more for a widget than you did. And its even more pointless to say you “lost money” because someone else paid less than that the next day. Whether you bought them with gold bars or dollars is not really relevant.

Perhaps the real question is whether we are talking about real money, or abstract points for keeping score.

It is a true change in value.

Its true value to you is whatever you ultimately sell it for, just like that farmer with his tomatoes. He doesn’t make money until they are sold. No matter how much other farmers got for their tomatoes.

“What is pointless is saying you made â€œmoneyâ€ because someone else paid more for a widget than you did. And its even more pointless to say you â€œlost moneyâ€ because someone else paid less than that the next day”

We are not talking about one person. We are talking about the market as a whole. We are also talking about a situation where the asset being valued is completely identical to those being bought and sold that day in the market.

“Lets be clear, the issue is not whether market estimates have uses. They do. But confusing the values they set with money in the bank is not one of them.”

If you don’t get it by now, I don’t think you’re going to. Money is only a single representation of wealth. It too fluctuates in market value, like any other asset. It does not matter whether your wealth is in dollars, yen, gold, puppies, real estate, or cattle. The same wealth can be held in each asset, and the value of that wealth will change as asset valuations fluctuate with respect to each other. Individual transactions from one asset type to another is evidence, but not proof, of that asset’s true market value. The true market value is an averaging of “buy price” and “sell price” for an arbitrarily defined period for all individuals in the market for that asset.

The counterpoint to your argument is simply this: if you purchase asset A for $x and then tomorrow and forever no one is willing to purchase asset A for $x, then asset A has fallen in true market value. There is no estimation here and it does not matter if you ever sell asset A for less. Your wealth has decreased.

Similarly, if you hold all your wealth in dollars and those dollars fall in value by 50% due to inflation or other means, then your wealth has decreased. You do not have to wait until you exchange those dollars for another asset. You may not “know” the change in value, but that has nothing to do with the fact that there IS a new market value and it is different from the original.

For the benefit of everyone, I will stop trying to explain this to you now.

For the benefit of everyone, I will stop trying to explain this to you now.

I will also stop trying. Perhaps Robert Shiller, the Yale economist of the Shiller-Case index, can do a better job:

“Robert Shiller, an economist at Yale, puts it bluntly: The notion that you lose a pile of money whenever the stock market tanks is a â€œfallacy.â€ He says the price of a stock has never been the same thing as money â€” itâ€™s simply the â€œbest guessâ€ of what the stock is worth.

â€œItâ€™s in peopleâ€™s minds,â€ Shiller explains. â€œWeâ€™re just recording a measure of what people think the stock market is worth. What the people who are willing to trade today â€” who are very, very few people â€” are actually trading at. So weâ€™re just extrapolating that and thinking, well, maybe thatâ€™s what everyone thinks itâ€™s worth.â€

Shiller uses the example of an appraiser who values a house at $350,000, a week after saying it was worth $400,000.

â€œIn a sense, $50,000 just disappeared when he said that,â€ he said. â€œBut itâ€™s all in the mind.â€”

You spend money on stock, but stock is not the same as money in the bank.
Exactly, and this is why – according to your logic – you lost money when you bought stock. When you trade money for stock, you lose an exact amount of money and gain stock. Then, when you sell, you gain or lose money.

Of course not. Nor does someone’s inability to understand a statement make it untrue. I thought maybe the Shiller quote would help clarify that this is hardly an idiosyncratic concept.

Exactly, and this is why – according to your logic – you lost money when you bought stock.

How is that my “logic”. If you spend money when you buy stock, you now own stock. You didn’t “lose” anything.

No one is suggesting the stock you buy is worthless any more than a house is worthless once you buy it. Or tomatoes in a warehouse for that matter. They have value, but they are not the same as money.

As, in the farmer who has tomatoes in his warehouse. One week tomatoes in the market are cheap, but he isn’t selling any. The next week they are expensive, but he still isn’t selling them. He doesn’t go home and say “Boy, I made a lot of money in the market this week.”

Instead, he understands that the only price that matters is the one he gets when he sells. That current market price only gives him a glimpse of what that price might be. And that tomato prices at the market may change several times before he is ready to sell his.

Warren Buffet quite famously buys stock in companies he thinks the market undervalues. In other words, he thinks the stock is worth more than the price the market estimates its worth. And he is usually right.

Itâ€™s discouraging to see all of your arguments summed up in quotes he made this past Saturday.

I am going to stop, since you obviously aren’t reading my arguments if you think that sums them up.

The fact is no one makes money when their home value increases unless they sell the home. The same is true of stock. And recognizing that is an important part of realistic financial planning. The folks who treated the market values of their home or stock as “money in the bank” are hurting.

How is that my â€œlogicâ€. If you spend money when you buy stock, you now own stock. You didnâ€™t â€œloseâ€ anything.

No one is suggesting the stock you buy is worthless any more than a house is worthless once you buy it. Or tomatoes in a warehouse for that matter. They have value, but they are not the same as money.

I wasn’t suggesting anyone was suggesting the stock is worthless. I was just stating that stock isn’t the same as money in the bank; therefore, you have less money because you traded it for stock. You won’t know how much money you have until you sell the stock. I am not introducing new arguments here – I’m recapitulating yours.

You gave your own examples expanded on *why* it was dangerous to succomb to Schiller’s ‘fallacy’, but much of what you’ve written seems extrapolated from his quotes. Both you and Schiller wrote:
1) unrealized stock (or any asset) changes are not the same as money in the bank,
2) stock prices are estimates – sometimes poor – of companies’ (or any assets’) true value,
3) stock prices (or any asset prices) are set by very few traders (market participants) each day.

Additionally, you used Schiller’s exact house price example (aside from quoting it). I may have missed some of what you’ve said, but most of it seems to fall into those three categories and the sentence prior to the list.

I never claimed that stock values are *always* the same as money. Stocks and money/cash are obviously different, but that does not make true the implications of the saying “don’t worry about the loss, it’s only on paper”.

Also, as you would probably agree, it’s not prudent to view unrealized capital gains as increases wealth. However, I think it’s equally imprudent to ignore unrealized capital losses as decreases in wealth. This is mostly because having less money than expected tends to pose a larger problem than having more.

“As the Yale economist Robert Shiller has pointed out, stock values arenâ€™t â€œmoneyâ€. They are just guesses of the stockâ€™s value based on what a very small group of people who are buying and selling today think the stock is worth at this moment. We extrapolate a value from that.

This is why, unlike money, stock value can just disappear and reappear.”

So if you are claiming some of my ideas come from Shiller, then you are merely restating the obvious since I attributed them to him from the start. So what?

I never claimed that stock values are *always* the same as money.

When do you think they are? And when do you think they aren’t?

Itâ€™s not prudent to view unrealized capital gains as increases wealth. However, I think itâ€™s equally imprudent to ignore unrealized capital losses as decreases in wealth.

The reason we call them “unrealized” is because they aren’t “real”. If you have a 20 year horizon for investments and no intention of selling or buying, then the current market estimate has almost no meaning in terms of the price you are likely to get in 20 years. The market price is very likely to go up and down several times between now and then. About the only use a current market estimate has is to rebalance your portfolio.

“If you have a 20 year horizon for investments and no intention of selling or buying, then the current market estimate has almost no meaning in terms of the price you are likely to get in 20 years.”

If that is what you have been trying to convey, you aren’t doing a very good job of it. If you had said that to begin with, I would have wholeheartedly agreed with you. Current valuation does NOT necessarily indicate what future valuation will be.

However, for you to take it a step further and say that the current valuation is the valuation at time of purchase and does not change until the asset is sold is misguided.

you to take it a step further and say that the current valuation is the valuation at time of purchase

I didn’t say anything of the sort. You seem to be using “wealth”, “value”, “market valuation”, “current valuation” and “money” as if they are interchangeable. So I have no idea what you are actually talking about.

Let’s take a simple example. If you have a government bond with a maturity of 30 years and hold it for 30 years you know exactly how much money it will produce.

There is also a market in bonds and that bond will sell at different prices during those 30 years. Those prices are irrelevant to someone who is holding it to maturity.

You can’t say they “lost money” just because they can now buy the same bond for less than they paid for it. Or that they “made money” because they can sell it for a higher price. Just like our farmer with his tomatoes, you have to actually sell them to make any money.

Ross, you have been talking about “money”, not me. I’m talking about the asset’s value. You seem very hung up on dollars. Dollars are just another asset with their own market value, which can and does fluctuate. When you exchange an asset for more dollars than you purchased it, you are not “making money.” The value of the asset has increased or the value of the dollar has decreased and you are engaging in a fair exchange between two assets. There is no increase or decrease in wealth during that transaction. That is the point I have been trying to make this whole time, and that is what I’m “talking about”, since you say I have been unclear.

“Again, I am struck by your comment. In fact your example is a great mental exercise to counter your argument. The very fact that one can refinance and â€œextractâ€ more money out of their home without selling is exactly evidence that the value has increased. It is not a â€œmind gameâ€ but real change in value.”

A lot of people believed that fallacy and are now paying a heavy price for it because they pledged their home as collateral on a loan they can’t afford to pay back.

JDâ€™s article talks about â€œInvesting in a Bear Market.â€ Considering the events of the last 3 months, perhaps the article is worth revisiting. The Dow fell from its peak of 14,279 on 10/11/2007 to 9,387 on 10/13/08 when JD posted the article. Yesterday (12/24/08), the Dow closed at 8468, down 5,811 points (40%) from its peak. Many GRS readers with long investment time horizons commented that they donâ€™t care too much about market volatility and see the current market climate as an opportunity to buy.

Of course, the market could head lower from here. Is it possible that the stock US market could follow in the footsteps of the Japanese stock market which peaked nearly 20 years ago when their real estate bubble burst? Today the Japanese stock market is mired at just 20% of its peak. What if that was the scenario of the US stock market 20 years from now?

If you could choose between two slightly different investment strategies (Strategy 1 and Strategy 2 below), and you had to live with your choice from now through retirement, which of the following would you choose?

–Both strategies would invest in exactly the same funds.

–From a historical perspective, both strategies returned a compounded annual growth rate between 11%-12% over 35 years through the end of 2007.

–Strategy 1 requires you to simply buy and hold (or dollar cost average into) a pre-determined group of funds. You will do nothing other than to spend about 1 hour per year rebalancing your portfolio. Even though the compounded annual growth rate for Strategy 1 was 11%-12% over the 35 years ending in 2007, the individual yearly returns of Strategy 1 ranged between -12% (worst year) to +27% (best year). The maximum portfolio drawdown from peak-to-trough was 20% measured monthly during that period. However, in 2008, Strategy 1 lost 36% of its total value.

–Strategy 2 requires you to spend about 6.5 hours per year (an average of 30 minutes every 4 weeks) reviewing the performance of the same pre-determined funds used in Strategy 1. Sometimes you will buy or sell individual funds based on signals generated by an unemotional, purely mathematical model. For Strategy 2 the compounded annual growth rate was 11%-12% over the 35 years ending in 2007, but the individual yearly returns of Strategy 2 ranged between +1% (worst year) to +26% (best year). The maximum portfolio drawdown from peak-to-trough was 10%. In 2008, Strategy 2 lost 1% of its total value.

Which strategy would you choose going forward?

Whether you are in a bull or a bear market, pick an investment strategy with risk characteristics that work for you. Follow the strategy without fail.

“Sometimes you will buy or sell individual funds based on signals generated by an unemotional, purely mathematical model.”

No such thing exists. The calculations may be unemotional but the decisions of what calculations go into the model aren’t.

Mathematical models that “predict” past stock performance are a dime a dozen. They are mostly just fancy ways to time the market based on some “objective” past performance. While every prospectus reminds people that past performance is no guarantee of future performance, most of us never really take that reality to heart.

2) Most of us are only rarely in “buy and hold” mode. With our retirement savings, we are either continuously buying prior to retirement or continuously selling after retirement. We do cost-averaging out of necessity, if not by design. The exception is if we get a windfall from somewhere.

3) The only real question for people who have their money in a balanced portfolio, is when to rebalance. At that point, you are going to be taking money out of cash and bonds and buying stock. But low, sell high, keep it simple.

Of course, “deciding” when to rebalance, rather than doing it on a regular schedule is still trying to time the market.

In my earlier experiences as a modeler, I sometimes found it an emotional challenge to follow my SISTM (Sage Investment Strategies Timing Model) without question. Sometimes the model would tell me to do one thing while my emotions tugged at me to do something else which might have seemed more logical at the time. Whenever I allowed my emotions to get the best of me and did not follow one of the signals, the SISTM almost always proved to be right.

Over time I gained complete confidence in my SISTM and disciplined myself to follow its signals. That confidence and self-discipline kept me out of trouble in 2008. Iâ€™m 60 years old and canâ€™t afford to lose a big chunk of my portfolio as I did during the 2000-2003 bear market before becoming a modeler. I designed my SISTM to optimize both nominal and risk-adjusted returns. I measure standard deviation, Sharpe Ratio and peak-to-trough drawdown and compare them with key benchmarks as well as a buy-and-hold portfolio.

Looking back at 2008, one of the most the most difficult and tumultuous periods in financial markets in the last 80 years, Iâ€™m very pleased with the performance of my SISTM. From 2007 onward, I invested 100% of my own, my wifeâ€™s and my motherâ€™s money using the â€œbuyâ€ and â€œsellâ€ signals that my SISTM generated. The results which I update weekly on my website speak for themselves.

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My name is J.D. Roth. I started Get Rich Slowly in 2006 to document my personal journey as I dug out of debt. Then I shared while I learned to save and invest. Twelve years later, I've managed to reach early retirement! I'm here to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you get rich slowly. Read more.

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